In a recent post, my colleague Casey Mulligan, who has been a critic of federal stimulus spending, made an important point about that spending – whether it is stimulative or not depends vitally on its composition. Government purchases – consumption and investment spending – add to growth, he said, but transfer payments do not. I wish to examine this point further.

To begin with, all data on economic growth come from something called the National Income and Product Accounts, a large, complex and interconnected accounting of everything we can measure that affects growth. The summary statistic that comes from this data is the gross domestic product. It has its faults, to be sure, but it is the best single figure we have to tell us how well we are doing, economically.

A change in any one of these categories has the same effect on G.D.P. as a change in any other. Thus, $1 of spending by individuals is the same as $1 of investment by businesses, $1 of exports or $1 less of imports, or $1 of either consumption or investment at any level of government.
I want to concentrate on the government category. The first thing to notice is that only consumption or investment spending adds to growth. But much government spending does not fall into this category. It consists of transfer payments – that is, taking money from one group of people and giving it to another. Interest payments on debts and subsidies to businesses are other major categories of government spending.

Much of consumption spending is for salaries to government employees but also includes various goods and services purchased and consumed by governments. Investment spending consists of public works and long-lived assets like Navy ships and Air Force bombers.

If we look at 2011, we see that nominal G.D.P. was $15,094 billion. Of this, the vast bulk was personal consumption: $10,726 billion. Investment was $1,916.2 billion. Exports were $1,473.4 billion. Subtracting imports of $2,664.2 billion yields a negative net export figure of $578.7 billion. Government consumption and investment at all levels was $3,030.6 billion, or 56 percent of total government spending of $5,409.9 billion.

Breaking down government spending’s contribution to G.D.P. further, we see that the federal government added $1,232.9 billion and state and local governments added $1,797.7 billion. Of the federal component, $824.9 billion was for military spending and $407.9 billion for nonmilitary purposes. Federal aid to state and local governments is netted out to avoid double counting.

The Bureau of Economic Analysis, the division of the Commerce Department that collects the NIPA data, calculates the contribution of each component of G.D.P. to its real (inflation-adjusted) growth rate:

Bureau of Economic Analysis

Government’s role in economic growth turned negative in 2011 because of budget cuts, subtracting more than four-tenths of a percentage point from the real G.D.P. growth rate. Federal consumption and investment spending for both military and nonmilitary purchases fell in real terms relative to 2010, and cutbacks at the state and local level were especially severe, as teachers and other workers suffered layoffs, which subtracted almost three-tenths of a percentage point from real G.D.P. growth.

With this framework for analysis, we can examine how the stimulus program enacted in February 2009 has affected the economy.

According to the federal Web site that tracks stimulus programs, $763.1 billion of the original $840 billion program has been disbursed. Of this, $297.8 billion, or 39 percent, went to tax cuts, like the Making Work Pay tax credit. Another $236.7 billion, or 31 percent, went for various contracts, grants and loans. And $228.6 billion, or 30 percent, went for transfer payments.

Thus we see that most of the stimulus was unlikely to ever have had much impact on growth. Transfers and tax credits only raise growth if they cause individuals and businesses to increase their consumption or investment spending. Undoubtedly they did to some extent.

But studies have long shown that people’s spending is largely a function of what they view as their “permanent income.” Temporary increases tend to be saved and thus do not add to spending or growth. Keep in mind also that the federal deficit constitutes negative saving, which offsets any increase in saving resulting from deficit-financed tax cuts or transfers.

The Bureau of Economic Analysis has put stimulus outlays into a NIPA framework. As of March 31, $452.6 billion of net stimulus funds had been disbursed in ways that show up in the national income accounts. Of this, the vast bulk, $399.7 billion, went for transfer payments. Another $9.6 billion went for subsidies and $68.1 billion for capital transfers to state and local governments. Only $37.8 billion went for consumption and $11.8 billion for investment – the only two categories of outlays that we know add to growth.

Thus it appears that only 11 percent of total stimulus outlays definitely added to growth; the rest may have had no effect at all.

I think that much of the criticism of the stimulus legislation on both sides of the political spectrum has been misplaced. Liberals tend to decry the small overall size of the original package, while conservatives say it was too big. But perhaps the very limited allocation for investment and consumption was the problem.

Potentially, we could have had a smaller program that was far more concentrated on consumption and investment spending that would have given us more “bang for the buck,” done more to raise growth at a lower budgetary cost, and maybe made both sides happy.

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